Mutuals close to becoming Solvency II- ready

Building societies are near to finalising an investment instrument which would enable them to meet strict new capital requirements without losing their mutual status.

"Mutual ordinary deferred shares" or Mods are instruments which would behave like bonds, with a capped coupon, but be loss-bearing for regulatory purposes, according to The Financial Times.

This is a structure which "ticks all the boxes", according to one building society chief executive.

Building societies have spent months trying to devise capital structures to comply with Solvency II, the European capital requirements directive.

Owned by their members, not by shareholders, they cannot replicate bank-style instruments which allow debt to be converted into equity in times of crisis without jeopardising their mutual status.

Some building societies, including Yorkshire and Chelsea, and West Bromwich Building Society, have already created Mods-type instruments in the form of "contingent convertible" instruments, CoCos. These convert into so-called profit-participating deferred shares (PPDS) in times of extreme stress.

However, building societies issuing PPDS as a way of raising capital must hand over a chunk of their profits, making the instruments unfavourable.

Mods would have a target fixed return but, in exceptional circumstances, societies would be able to renege on paying it.